Spirit AeroSystems Holdings Inc (SPR) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Spirit AeroSystems Holding, Inc.

First Quarter 2010 Earnings Conference Call.

My name is Carissa and I will be your coordinator for today.

(Operator Instructions).

I would now like to turn the presentation over to Mr.

Alan Hermanson, Director of Investor Relations.

Please proceed.

Good morning.

Welcome to Spirit's first quarter 2010 earnings call.

I'm Alan Hermanson and with me today are Jeff Turner, Spirit's President and Chief Executive Officer; and Phil Anderson, Spirit's Senior Vice President and Chief Financial Officer.

After brief comments by Jeff and Phil regarding our performance and outlook, we'll be glad to take your questions.

In order to allow everyone to participate in the question-and-answer segment, we do ask that you limit yourself to one or two questions.

Before we begin, I need to remind you that any projections or goals we may include in our discussion today are likely to involve risks which are detailed in our news release, in our SEC filings, and in the forward-looking statement at the end of this web presentation.

And as a reminder, you can follow today's broadcast and slide presentation on our website at SpiritAero.com.

With that I would like to turn the call over to Jeff Turner.

Thank you, Alan; and good morning.

Let me welcome you to Spirit's first quarter earnings call.

I'll begin with a look at our business and associated performance, then Phil will walk us through the financial results, and after that we'll be glad to take your questions.

We executed well across the company as our core businesses continue to perform and deliver solid financial results in line with our expectations.

While executing our core business during the quarter, we continued to meet development milestones on our new programs.

Our teams are doing a good job of working with their customers to accomplish program commitments.

With that said, the next two years have numerous development challenges still remaining as our teams continue to focus heavily on program execution while moving these programs through their initial stages to production.

I continue to be pleased with our progress on the 787 program as we begin to flow the early stages of low rate production.

It's exciting to see the progress on the 787 and we look forward to a long and successful program.

As for the outlook of the commercial aerospace market, the down cycle hasn't materialized for large commercial aircraft and in fact many in the industry are now forecasting increased production.

With these changing dynamics, the long-term prospects for Spirit are improving as we are strategically partnering with world-class customers on the next generation of large commercial business and regional jets.

Because of this product foundation and its solidity and the global economic outlook showing improvement, we are becoming more optimistic regarding the outlook for the commercial aerospace market; however, we remain concerned about certain segments of the business jet market.

While our teams are highly focused on execution and fulfilling customer requirements, we continue to strategically analyze our business to ensure we are postured to meet the potential growth needs of the industry.

Overall the implementation of our long-term strategy is driving diversification and our business foundation remains stable with a backlog of $28 billion.

Now let's talk about some of the specific accomplishments across the business during the quarter, beginning on Slide 3.

Fuselage Systems delivered solid double-digit operating margins of nearly 15% on $516 million in revenue during the first quarter of 2010.

These results include cost growth for the Sikorsky CH-53K program due to additional development activities supporting the successful completion of the critical design review.

The core business continues to perform and we now have delivered more than 3,200 chipsets of the 737 next-generation fuselage.

The team also demonstrated progress with newer derivatives.

We shipped the 29th 777 freighter and the 15th 747-8 freighter forward fuselage.

Our fuselage new programs are also advancing.

Our Airbus A350 XWB development teams continue to partner with Airbus focusing on technical and schedule requirements.

On Slide 4 you see the Propulsion team delivered solid operating margin of 12.2% on $274 million in revenue during the first quarter of 2010, which includes impacts from the challenged after-market business.

The core business continues to execute by delivering high volumes of 737 next-generation line units, surpassing line unit 3200 in the quarter.

Additionally, we are progressing on new customer hardware.

In particular we delivered our 20th chipset of 787 engine pile-on, our seventh 747-8 engine inlet, and our tenth 747-8 pile-on chipset.

The Propulsion segment continues to make progress on development programs by delivering the fifth inlet and thrust reverser units for the Rolls-Royce BR725 engine on the Gulfstream G650 business jet.

Our team continues to work closely with the customer while transitioning to initial stages of production.

Additionally, our pile-on teams supporting the design and build of the Bombardier CSeries and the Mitsubishi regional jet continue to progress well in the early stages of development.

On Slide 5 you see the Wing Systems segment which comprises our Spirit Europe, Spirit Malaysia and Oklahoma operations.

The wing team delivered operating margins of 7.6% on $249 million in revenue during the first quarter of 2010.

The results include an unfavorable contract adjustment associated with the transition of the Hawker 850XP program back to Hawker Beechcraft by 2012.

Activities in Spirit Malaysia continue progressing well with another milestone reached as we are now in full production rate across all planned A320 deliverables.

Our AeroStructures team in Tulsa continues to execute well on core products.

In particular the group delivered the 15th 747-8 leading-edge wing section.

Tulsa's Gulfstream programs continue to show progress.

They delivered the fourth G250 wing, shipped the fifth G650 wing, and continue to support the respective flight test activities.

Our focus continues to be on fulfilling our customer's schedule and technical needs with emphasis on cost improvement and weight reduction activities.

We continue to work closely with our customers as we transition from full development activities into production.

Now let me turn to Slide 6 and give you a brief update on the 787.

We delivered airplane fuselage number 20 with five forward fuselage shipped in the first quarter.

Our 787 composite forward fuselage fabrication area is making good progress as we continue to transition the production line to low rate levels.

The factory line has been filled with work-in-process units and our flow is supporting the production requirements.

Overall product quality remains as we continue to incorporate the necessary engineering changes on the initial end-service airplanes.

Production readiness continues to be a focus area for the team as we ensure both internal processes and our supply base are prepared for a progressive ramp-up of production.

As our production continues to mature, our internal efforts are constantly focused on productivity improvements and efficient asset utilization.

Now let me turn it over to Phil who will provide more details on our financial results and outlook.

Thanks, Jeff; and good morning.

I'll begin with our key financial highlights for the quarter on Slide 8.

Revenues for the quarter were $1,043,000,000 up 18% compared to the first quarter of 2009 as the effect of the machinist strike at Boeing in late 2008 reduced first quarter of 2009 volumes.

Operating margins were a strong 8.9% and fully diluted earnings per share were $0.40 per share in the quarter compared to 11% and $0.45 per share respectively in the same period of 2009.

Current quarter results reflect the anticipated performance in the current accounting blocks, higher interest expense and other income expense of approximately $6 million, mainly associated with Spirit Europe's investment in the A350 program and FX impact on borrowings.

This FX loss is reflected in the Other line on the income statement as gains and losses on FX are non-inventoriable costs.

These headwinds were partially offset by favorable tax benefits in the first quarter of 2010.

Effective tax rate in the quarter was 24%, reflecting the outcome of an IRS examination protection of 2005 and 2006 that was completed during the first quarter of '10.

Lastly, first quarter cash flow from operations was $110 million use of cash, an improvement of $39 million as compared to the first quarter of 2009, primarily reflecting working capital improvements compared with the prior year quarter.

Capital expenditures were $69 million as we continued investment in our new programs.

On Slide 9, R&D expense in the first quarter was $10 million, down from the prior year period as certain R&D projects for our A350 program completed in 2009.

SG&A expense for the quarter of $39 million was essentially flat to the prior year.

Combined, R&D and G&A expenses improved as a percentage of sales from 5.9% for the same period of 2009 to 4.7% this quarter as absolute dollar spending of R&D was lower and sales grew from the first quarter of 2009.

We continue to aggressively manage our period expenses.

Slide 10 summarizes the first quarter of 2010 and fourth quarter of 2009 cash and debt balances.

Cash balances at the end of the first quarter of 2010 were $187 million as compared to the year-end 2009 balances of $369 million, largely reflecting new program inventory spending in the first quarter of '10 and receipt of planned non-recurring contract payments associated with our development programs in the fourth quarter which increased year-end cash balances.

Total debt balances increased slightly in the quarter due to additional capital lease commitments.

At the end of the first quarter our total debt to capital ratio was 36% which is flat to the year-end of 2009.

The company's $729 million revolving credit facility was undrawn at the end of the first quarter 2010 as well as at year-end of 2009.

This facility will step down to $409 million in capacity in June of this year as planned and the maturity of that facility is June 2012.

We continue to believe that this level is more than adequate to fund projected cash flow needs.

As of the end of the first quarter 2010, we had approximately $900 million of short-term liquidity available through our revolving credit agreements and available cash balances.

Slide 11 details our cash flow for the first quarter of 2010 versus 2009.

Cash flow from operations was $110 million use of cash as spending on new program inventory continued but slowed as compared with the first quarter of 2009.

Additionally, favorable accounts receivable performance in the first quarter of 2010 was partially offset by improvements in accounts payable in the same period of 2009.

The current year growth in inventory was primarily driven by continued investment in the 787 and other new programs and partially offset by higher 787 unit deliveries.

And capital expenditures were $69 million for the quarter, up $15 million from 2009, primarily due to investments in our North Carolina facility.

Slide 12 summarizes our previously issued guidance for 2010.

As we mentioned to you last time, 2010 is a pivotal year for Spirit as we grow and diversify our business.

The core components of our business remain strong as we work to bring next-generation large commercial aircraft and business jets to the market.

We are maintaining our financial guidance for 2010.

Our revenue guidance remains at between $4 billion and $4.2 billion with fully diluted earnings per share unchanged at between $1.50 and $1.70 per share.

Cash flow from operations remains at approximately $75 million and capital expenditures are expected to be approximately $325 million as we continue to invest in growth.

Our guidance continues to consider some market uncertainty and development program risks.

Additionally, we are clarifying our expectations for the company's effective tax rate in 2010.

We previously expected the tax rate to be between 30% and 31%.

The previous guidance assumed the extension of the U.S.

tax credit.

Now we expect 2010 tax rate to be approximately 27% and continue to expect the extension of the previously mentioned tax credit.

I'd now like to turn it back over to Jeff for some closing comments before we take your questions.

Thank you, Phil.

I'll wrap up on Slide 13 with a few brief comments.

We had a good first quarter as our core businesses continue to focus on its execution.

With an improving outlook for our core products, our company remains well-positioned within the aerospace industry.

While we are watchful of the aerospace market dynamics, we continue our pursuit of productivity and efficiency improvements across the enterprise while meeting our customer commitments.

Looking forward, our focus will continue to be on core business performance and execution of new programs while keeping our business healthy and our team for the future intact.

With the ramp-up of various new programs, supportive multiple programs for flight tests and continued new program development, 2010 remains a pivotal year for Spirit.

We continue to make significant progress by executing our long-term strategy.

With a strong backlog, growing and diversifying our business profitably remains the foundation of our strategy as we continue our focus on long-term value creation.

We will now be glad to take your questions.

(Operator Instructions)

And your first question comes from the line of Doug Harned of Sanford Bernstein.

Please proceed.

Good morning.

Hey, Doug.

I'm interested if you could help us some on understanding where things stand right now with Boeing on the 787 in terms of negotiations for design changes, the status of the 787-9, and also, say, in terms of what you're seeing coming through as you now go.

You've gone through -- you're past the 20-block point, are you seeing more changes there, and how would that be impacting your performance?

Okay, Doug, let me start and then Phil can add some color if need be.

So that's a multi-part question, so let me just talk for a minute about the 787.

We talked about our production ramp-up, our focus on efficiencies and getting the supply base lined out and running efficiently.

We're happy with where we are at this point in time.

Clearly the issue we have on assertion discussions are ongoing, this is a priority for Spirit.

Frankly, not moving as quickly as we would like it to, but we are seeing some movement.

You have seen us settle one of the three components that we have in the past.

Engineering change is still an issue for us.

We are working to get the engineering changes incorporated at the appropriate time.

We're seeing some of that begin to slow down which is appropriate for this stage of the program.

And of course we stay very close to the program as it progresses through flight test.

And as you look at your R&D requirements, I mean you said that R&D has come down year-over-year, but is your engineering headcount coming down as well?

Well, clearly we're off of the peak of the development period, so the number of engineers that we have applied to the program are less than they have been in the past.

It's frankly still higher than we would want at this point in time.

But it has come down from where it was at the peak.

Hey, Doug, this is Phil.

The only thing I would add is, as we move through 2010, '11, we'll be getting more focused on the dash-9 development which will increase (inaudible) as we go through '10 and '11.

I guess what I was wondering is if engineering -- basically R&D comes down yet engineering headcount stays the same or maybe even goes up a little bit, where does that cost go or is there something else going on in terms of overtime or contract labor that would be bringing R&D down?

Yes, well, the two components of R&D, one is the new program component which the dash-9 would fall into, the other is our core R&D expenditures which that's one of the things I would say we're managing with a little higher scrutiny as we move through this development cycle.

We're really focused on capital allocation with the right projects in R&D.

So I think you should -- as we look forward, we'll work to offset some of our core R&D and then move that into the new program phase versus just growing the R&D on an absolute basis.

I see.

Okay, okay.

Thank you.

Yes.

Thank you, Doug.

Your next question comes from the line of Ronald Epstein of Bank of America.

Please Proceed.

Yes, good morning.

Good morning, Ron.

There's been a lot of discussion about re-engining.

If Boeing were to re-engine the 737, what's that present for Spirit?

I mean are you automatically the new sell on the new plane, or how would that work?

Well, just categorically we do these -- the ideas of refreshing products or even new development as exciting opportunities for us to use our strength and to grow our presence with customers and certainly in the marketplace.

Specifically on the 737 that you asked about, we would fully expect to be the partner of choice on these products that we build today.

Our focus would be on helping the customer bring a great product or [create] the product if they so choose to the marketplace, and by doing the design and build that we know best, and helping bring a great product to -- keep a great product in the marketplace.

Now, Jeff, if you step back and you look at a lot of the new product development that's gone on over the last couple of years, it seems like pretty much everything has gone over-budget.

If you think about new programs down the road, A350, anything else, re-engining, how -- what lessons have you learned that that won't happen again?

Well, a couple of thoughts on that, Ron.

I think new programs in and of themselves are challenging and the more new technology that gets deployed, the more challenges to get all that to come together at the same time.

So we have looked very closely at what we bid, how we bid it.

We've looked at how we take our engineering capability and use it to access a broader range of engineering partners around the globe.

So I think partly we were less ready to do that than we obviously needed to be.

I think we tried to anticipate maybe the risk better.

I mean if you think about where we are today, we have, I think it's either six or seven, brand-new products in flight test at the same time.

If you went back and looked at the original plan for that, you wouldn't have seen that kind of stack-up.

So part of it will be in the robustness of our contingency planning.

Clearly new programs tend to come along at roughly the same time period, so we're figuring out the processes that will allow us to respond to that multitude of demand and still have the contingency to surge if we need to based on programs moving in time to where they overlap each other.

And then maybe just one last question for Phil.

In the press release you talked about cash flow getting better in 2011.

I was wondering if you can give us maybe some more color around that.

I know you can't be all that specific, but if you can just give a better feel for it.

Well, the color was pretty clear, we expect it to be a lot better in 2011 as we move through the development cycle, right?

350 factory in North Carolina comes on line this year, in fact I think we just took over the factory here recently from the construction team.

So 2012, or I'm sorry, 2010 is a big spend year, I think in this current development cycle with the current work statement we have.

And 2011, certainly gets a lot better.

A lot of 2011 will depend on how these development programs play out in flight test.

If they move to the right, then they may require a little more cash than what we have in the plan now.

So I think I'll just stick with the commentary that it gets a lot better in 2011 without giving you much more.

Okay, thank you.

You bet.

Your next question comes from the line of Cai von Rumohr of Cowen and Company.

Please proceed.

Yes, thank you very much.

So you had your second quarter in a row with a charge on the CH-53.

Could you kind of give us an update on new programs with respect to the risk level of like the 53, the BR725 where your 10-K indicates it's breakeven, the 650, and the 87 where I guess there's some rumors that Boeing has kind of slowed delivery from suppliers so that they can kind of get some of the other guys caught up?

Cai, let me just start that and let Phil add flavor if he needs to.

I think this whole issue we talked about in terms of risk of new development programs is something that we've spent a lot of time and energy on.

If you look at all of our development programs, they really fall on a spectrum from some of them having executed pretty much to the plan, flowing into production in good stead, and then some have been more problematic.

And we spend a lot of time on lessons learned, and frankly spending a lot of energy on getting those flowing better.

As we look forward, I think the real issue on the programs and the risk associated with them is we're 60% plus now through the development of these heavy [slugger] development programs.

We are bringing them on line and getting in a position where we're focused on the production side of that where we can really bring a lot of our manufacturing and manufacturing engineering expertise to bear.

So I see that risk, you know, clearly we said 2010 is a pivotal year, I see that risk beginning to abate as we come through the slug of development.

If you were to characterize the programs with greater risk, you mentioned some are better, some are more difficult, clearly 53 -- CH-53 looks to be one of the more difficult ones.

Which of the -- the one -- two or three, the ones that you really have to put the most watch list effort on?

And when might we get to the point where that 60% through is like 80% through and the risks should start to abate fairly importantly?

Yes, let me address, I apologize I didn't address the CH-53K.

The CH-53K is we've spent more on the development of that than we had planned.

We got through a critical design review on that and frankly it was a learning experience for our team.

It's our first helicopter, it's with a new set of customers.

And frankly, critical design review means different things to different customers in terms of the level of maturity.

This is a program that we're happy with.

We spent a little bit more on the STD phase but we're very pleased with what we've come out with and believe that's going to be a great program for us long term.

So it's kind of -- it's [two-sided]; we would have liked to execute it exactly to our forecast.

And we've talked, probably the far of the end of the scale, we've talked a lot about the G250, big challenge for us on the G250 now.

We're delivering wings.

Big challenge is what's the market going to do?

And we all know it's focused on part of the business jet market that's not exactly robust right now.

So we think that's a great airplane and we think it's performing well.

We think the wing is a great wing.

Going to clearly do its part to make that a winner in the marketplace, but clearly we'd sure like to see -- we'd like to see that market recover and a lot stronger demand for the products.

So pretty much the business jet side has been tougher for us, probably because the learning curve was steeper for us there, and then of course the bigger airplanes I think we've performed well on.

Cai, I think the only thing I would add is all these programs are -- have change associated with them and some of them are customer-driven, some of them aren't.

So, not unlike the 787.

Not clearly the magnitude, but there are little things we continue to work with our customers to try to settle from a claims basis.

Thank you very much.

You're welcome.

Thank you, Cai.

Your next question comes from the line of Troy Lahr of Stifel Nicolaus.

Please proceed.

Thanks.

Just wondering if you guys could talk about your sales guidance a little bit.

I think the midpoint indicates that sales are going to be down maybe 3% to 5% over the next three quarters.

Can you help us kind of understand that process there, and with 787 kind of ramping, I assume some Gulfstream work is going to start ramping up?

I know you have lower 777s, but still why do you get the sales declining in the rest of the three quarters?

Well, I think you kind of run -- do a run rate, Troy, out through the next three quarters, you kind of get to the $4.1 billion-plus range.

That said, I think the dynamics are -- the biggest quarter-to-quarter variance we'll see is as we move through and work out development program payments from the customers.

Those tend to be lumpy, and when you get them done, you get them done.

But the rest of the core business is functioning fine, and I think the first quarter really reflects largely just the revenues and volume generated from the core business.

Okay.

But are you still seeing growth in the core business excluding some of the payments and things like that?

Yes, that really means a fairly stable year, for 2010, we're locked in.

We're really looking at volumes in 2011 and beyond at this point.

So 2011 is -- 2010 is very stable for us.

Okay.

And then also on the margins, can you talk about that a little bit kind of excluding some of the charges that we saw, and maybe help us understand the block changes?

Is this kind of a run rate we should expect for most of the segment margins going forward kind of excluding the charges that you guys took?

No, I think that's right.

I think this is in line with what we've talked about at the fourth quarter call when we rolled out 2010 guidance.

I think the only exception to that are the things you mentioned and the after-market.

We don't have a big after-market business but it's still been impaired like some of the other after-market suppliers out there.

So -- and most of that flows to the Propulsion segment, so it had some -- a little more deeper impact this quarter than what we would have liked to have seen.

But other than that, I think you're largely looking at the profitability in the current contract -- which I might add is not bad.

The 9% operating margins for Spirit as a tier 1 industrial kind of company are reasonably good margins for us.

Okay.

Thanks, guys.

You bet.

Thank you, Troy.

Your next question comes from the line of Howard Rubel.

Please proceed.

Thank you very much.

Sorry about the name, Howard.

I've been called worse, thank you, Phil.

First, could you give us, work through some of the inventory items, the 787 inventory, the pre-production in the Gulfstream, and the total pre-production and deferred on the 7-8 please?

Sure.

So deferred continues to grow as we deliver the airplanes.

I think it's -- we'll roll it out in the Q, the exact numbers, but we're still generating quite a bit of an excess over average on the early units, although it is coming down.

Pre-production on the 7-8 is coming down as well as we deliver.

That stopped growing in kind of mid to late '06.

Right.

So as we deliver that it's trailing off.

We are seeing pre-production growth in the Gulfstream programs as they get closer to production and I think a little bit of pre-production on 747-8 growing this quarter.

But you -- were we going to get to Q today or are we going to have to wait a little bit?

It's about a week or so away, Howard.

All right.

Since you didn't answer this question, could you try this one then?

Could you give us a sense of the size of the receivables that we have that are in negotiation with customers?

Most of it's inventory, it's not in the receivable, Howard.

So as we -- I think we're being very conservative about how we treat those as we move through time, get them negotiated, then we'll roll to the receivable and revenue as we get them cleared up.

And then I just want to go back to the 7-8 and I'm done, is you and Jeff both indicated you're making progress.

Could you give us an indication of the -- I know it's only 20 units or so, but could you give us an indication of the learning curve you're seeing and what sort of curve you're targeting?

No.

Got to --

That's -- pardon?

Well, we're seeing a good learning curve, as you can appreciate, T1 was very high due to a lot of factors, there's a lot of change in it, but we're seeing classical curves.

When you have a very high T1, you have a pretty high curve for the early part of the program.

So it's not at all out of line with what our expectations are given the environment that we're in.

But the specifics of the curve, Howard, I don't want to -- that's got some real sensitivity to it.

Let me give you -- just make sure we get a little sense of where we're out in the program, the units we are working on here in April 2010 were units we've had in the factory now for over two years, so we've yet to kind of get through the inventory we had built up prior to all the schedule moving around on us.

So it's a little early to really talk about overall learning curves given -- I don't think we've delivered one unit yet that's flowed through from start to finish in the standard flow time.

Then maybe you can say span times are coming down now?

Well, yes, you expect it to be --

Sure, sure.

-- absolutely, yes, yes.

All right.

Thank you, gentlemen.

Yes.

Thanks, Howard.

Your next question comes from the line of David Strauss of UBS.

Please proceed.

Good morning.

Good morning, David.

So on your blocks, what -- have you made any changes to your block assumptions within the guidance.

Are you incorporating -- are you still incorporating kind of 28 on the 3-7 and five on the 777 and one and a half on the 4-7 despite Boeing going up on the 4-7 and 777 and also giving indications that they're going up on the 3-7?

Yes, I mean the ones they've announced were certainly looking at that in the (inaudible) right now.

The 3-7 hasn't been announced but certainly we look out at the firming order base and Boeing's comments too, and we think the 737 is firming up in 2011.

So some of that's reflected in our 2010 guidance to the extent that's actually been announced and committed by the customer [and some] is still yet to come.

So within the guidance, is it fair to think that the -- I know we have a $0.20 range, but did it adjust?

I mean, did it move up within that range given the fact that the block accounting should be more favorable now?

Well, I think -- yes, clearly there's margin improvement as volumes increase.

But the broader picture for the company from a guidance standpoint really reflects back to the development programs.

So we're just in the first quarter, we'll see how this year unfolds as we go through it.

And we'll get smarter and we'll -- the development programs will firm up.

But I think overall your sense is right, as volumes go up, we're going to get some benefit from that.

But it's just not -- we're not changing the guidance because of other things at this point.

Okay.

And then, Phil, on depreciation, I think you had talked about that being a headwind going forward.

When are we going to actually start to see the depreciation pick up?

Yes, I think you'll see as we go through this year, David.

Okay.

All right.

Thanks, guys.

Thank you.

Thank you, David.

Your next question comes from the line of Robert Spingarn of Credit Suisse.

Please proceed.

Good morning, guys.

Good morning, Rob.

Jeff, I don't know if this is a question for you or for Phil, but -- and this sort of alludes to David's question.

You get about a $0.10 benefit from the lower tax rate for the full year, you also potentially have some of this margin lift that you just talked about with if there's some block changes, yet the guidance held, and it sounds like development programs are the issue.

Could you get more specific with what these pressuring offsets are?

Is there more to come in a couple of these programs?

Well, I think the -- as I mentioned before, Rob, the big issue is we have six of these in flight test at the same time, and we're bringing all six of them into production and ramping that production up at the same time.

And I think -- I just think we're being prudent in the way we're looking at them and not assuming that everything is going to go smooth on every program.

I guess it just sounds like the decision has already been made, that the assumed margins or performance on some or all of these has deteriorated since last quarter.

Specifically on the development programs, Rob?

Yes.

Unless it's somewhere else, Phil.

No, I think the, our 10-K, we talk about BR725 which is the cell package for the G650 on the Rolls-Royce engine.

It's a zero margins, 250 where it's at.

So I'd just reiterate Jeff's comments, and this is a pivotal year, core business looks strong and looks like it's going to get strong as we move to '11 and on.

And we are being appropriately I think conservative given the volume of development going on.

Okay.

Separate question then, because it just sounds to me like it's a little different now at the end of Q1 than at the end of Q4, for example, and the helicopter charge is to some extent evidence of that two quarters in a row, and maybe it's just these things, this is the way they work.

Is there anything particular about your assumption model that just doesn't allow you to capture certain variability in certain types of costs?

No.

No, we look at every contract every quarter in a very detailed fashion and we look at the risks and opportunities and roll out the appropriate guidance for the company.

Okay.

The only thing I would add to that, Rob, is clearly there have been more risks that came home, if you will, to roost on some of these development programs than we had in some of our earlier forecasts.

So we just think given, again, I think six airplane programs in flight test at the same time is a big deal.

And to assume that we have every contingency covered exactly is in our opinion not prudent.

So I think given -- not that anything's gone horribly wrong at all, that's not the point at all, I just think it's appropriate for us to take the level of contingency and conservatism that we're taking.

Okay, fair enough.

One last thing, Phil, you -- I know you didn't want to get in to the cash flow too much for 2011 but you did talk about swing factor being CapEx, in particular A350.

Can you at least give us some color on how that number changes this year to next?

Yes, the CapEx will be a little lighter in '11 we think at this point given the current outlook.

The other big swing factor is the cash [mobs], as we -- we will actually in 2011 start generating cash on the 787 again.

That's a big hit when this year we paid back that customer advance from the initial 45, 50 airplanes.

And if I recall, that happens around late first quarter, early second quarter next year?

Yes, that's about right, Rob.

Okay.

Thanks, guys.

You bet.

Yes, thank you, Rob.

And your next question comes from the line of George Shapiro of Access 342.

Please proceed.

Yes, good morning.

I just want to --

Good morning, George.

-- pursue a little bit David's question.

Did you actually provide to us what pool sizes or production rates you were assuming in the current pools?

And if you did, then I apologize for missing it, but I --

No, George, we didn't provide specific rate guidance by program in the current guidance.

What we have done is I think through 2009 we talked about the size of the next accounting blocks which we are now in the midst of and starting.

The first accounting blocks were formed when the company started and most of them ended around 2009, some flow over to this year.

So strategically how we think of the next accounting blocks, roughly the next two years.

So 2010 and 2011 would largely consume the next accounting blocks.

And so I think there's been some extrapolation on what that means to production rates, but that's basically what we've said about the next block.

Yes, I mean like the assumption was 700 737s, but I mean so you can kind of work around what you think that implies obviously.

But have you -- you haven't given any more specifics in terms of saying like the block size you're going to assume 31 or 33 or you -- we're assuming 29 or that kind of thing.

No, because really the block -- the 700 won't change.

The fill rate of that 700 would change based on the production rate.

Okay.

So if we run 31 a month for the next two years, we would complete that accounting block sooner rather than at a slower rate.

Okay.

And then, Phil, if you could just get into, how do you assume the costing is going to be in the block for say the IAM contract that expires in June, it obviously hasn't been negotiated yet?

Well, let me just answer that.

We obviously make a forward projection and a forward projection on the cost rate and that's what we use in the block.

Okay.

And Jeff, I mean I guess it's a little bit early to start any negotiations on that, but can you kind of give us any color, is it -- to what you might think the issues might be?

Yes, George, I'd be glad to.

We've actually started, we had a kickoff probably a month ago now.

Very positive kickoff.

We actually had the Head of the International Association of Machinists, Tom Buffenbarger and Dick Gephardt and myself address both our management team and all the shop stewards, and then -- and talked about, frankly, a new process between labor and management focused on keeping the company healthy and keeping the team we need for the future intact.

And negotiations have been underway.

I am frankly optimistic that we'll find solutions that meet the company's needs and the needs of our employees and -- because I think in most cases those are highly aligned.

So I'm anticipating that we'll continue to go through the negotiation process in good faith and come out with the process that'll be healthy for the company and healthy for our employees.

Okay, thanks.

And then just one detail one maybe for Phil.

Wing Systems margin X of charge [seats] still seem pretty low.

Is there anything unique to Wing Systems?

No, not really, George, other than what we've talked about which is the next block, you know, profitability.

But I would say, Wing Systems in general has a higher percentage of developmental programs underway than our other two segments.

Okay.

Thanks a lot, guys.

Thank you, George.

Thank you, George.

Your next question comes from the line of Joe Nadol of JP Morgan.

Please proceed.

Thanks, good morning.

Good morning, Joe.

Just first off, I'm coming back to something that someone asked earlier I think but maybe a little bit more detail, on this -- the press reports, and actually Boeing's spokesman I think came out and said that there's this 25-day delay on the 8-7, and it seemed to me that all of you, you being the major structural suppliers, are getting parts in late.

Could you give a little more color on that, Jeff, what exactly are you seeing there?

Is it something that's affecting everyone?

And did suppliers, third tier suppliers go bankrupt during the two years since you ordered parts?

Just what exactly is going on there?

Well, let me just talk it from Spirit.

We -- anytime you ramp up, you have some -- you have challenges, but clearly they were within the envelope for us of what we expected.

Our suppliers have been pretty solid.

The engineering change, traffic, as I mentioned earlier, has caused a little bit of issue with some of our supply.

But we've been seeing an increase in our -- in what we call our percentage of completion, it's very high.

What do we call that?

The condition of assembly.

Our condition of assembly which is all the parts we need to have on the units and ready to go.

We've seen that condition of assembly move to very high levels, high 90s percent.

So it's solid.

I think some of the challenges -- in some ways we're fortunate our suppliers have been pretty solid.

So this is a minimal change for us, the schedule impacts.

We actually are operating on a pool system with Seattle now on the programs, so we will just change a little bit the pool signals we get.

And it looks to us like it'll only impact the fuselage.

So you delivered 20 units by the end of Q1 and this is an issue that apparently starts with unit 23.

So is it fair to say you're going to deliver that unit 23 this quarter or you're only going to deliver 21, 22, and then the rest of it slips into Q3?

If you can --

Well, we haven't forecast that specifically and we'll deliver them when they pull.

I think 23 is ready to go and it'll go when they pull it.

Okay.

And I don't -- I frankly don't know specifically when that'll be.

Okay.

Just a couple of what some might call pencil pusher detail questions.

So...

In that case, I'll probably give them to Phil.

Yes, yes, that's where I'm going.

-- refrain, Joe, you can refrain that.

The currency hedge, Phil, can you just explain that again?

Is that something that's just sort of a non-recurring just because of the movement in the quarters we should expect nothing there going forward?

Yes, so it's actually -- it's not a hedge.

It's actually Spirit Europe buys engineering services in dollars, the pound-based functional currency.

So as they spend money and get a payroll there and it's -- the balances there is mark-to-market every quarter, so it's really the movement of the pound from like 1.62 to 1.52 in the quarter, it had accounts payable balance and some other borrowings that drove that.

Okay, so it's a true-up on a contract then, so it is kind of a one-time as long as the currency remains flat from here?

That's correct.

And then back on the depreciation issue, if these are -- the run rate margins, if depreciation ramps up through the year, is that already captured in the run rate margins or is that incremental pressure?

No, that's capturing the run rate margins.

Okay.

Okay.

And then just one more final thing, Phil, can you quantify if Boeing does indeed raise the rate to 34 from 31, what's the cum catch or what the impact on margins could be, just even approximately in basis points?

No.

Okay.

All right.

But let me -- so let me -- Joe, we look at it and again volume, this is a high concentration of asset business, capital goods, and volume is favorable, and we look forward to higher volume on that program especially.

Yes, let me give just a little bit of color I think would be appropriate, Joe.

As long as rates increase inside our capacity, if you will, it's clearly a good thing for us, although we do end up with some additional volume discount pressure, but net-net it's positive for us.

Once we began to hit the capacity constraints, then it becomes a little more dicey in terms of what it takes to expand, if you will, what we'd call our protection rates which is really the capacity lids that we have.

And so at some point in time if rates continue to rise, it's got some implications to us on the capacity we need to lay in.

And Jeff, just remind us finally, you're at -- on the fuselage on the 3-7, you already can do 34?

We're doing 31 and 34 is clearly not as big a step as something beyond that would be.

Right, got it.

Thank you.

Thank you.

Operator, we have time for one more question.

Your final question will come from the line of Heidi Wood of Morgan Stanley.

Please proceed.

All right, so I'm batting cleanup.

That actually gets right into a question I was thinking anyway which is that, can you -- what is the maximum capacity that you have on the 737 rate?

Is it 35, 36?

Heidi, I don't think we've ever really disclosed that.

And frankly, I mean as of right this minute, it's what we're running.

But we've got plans to expand that capacity.

And we can go up.

We'd go up 10% or so from our current rates within kind of the envelope, and then depending on how quickly that would ramp up, if it would need to ramp up beyond that, if there was little time to stabilize and work some lean efficiencies and maybe just put in some constraint-relieving processes or tools or whatever, we can continue to inch it up.

But I mean clearly we're running -- I mean you've seen our factory and you know it's pretty full.

So we clearly, if we got in to a mode where we needed to raise rates 20% or more, I think we'd -- we have to find some alternate approaches.

All right, thank you.

And then can you bring us up to speed about the -- how discussions with Boeing are progressing on the dash-9?

And this plan ramp to 10 a month, I mean how do we think about when the drop-dead date when you need a contract in order to achieve this plan ramp of 10 a month by 2013?

Well, typically we think about 18 to 24 months lead time on major step changes.

As you can appreciate, dash-9 activity is something that we've had on the plate for a long time and have underway, so that's pretty much in our forward view and in our plans.

But I mean all these things, what the rates are going to be and ramp-up, that's something that we deal with continually.

I'm just wondering whether you're sort of seeing a maturing on these.

I know they've been up in the air for quite sometime.

Is it coming to fruition, is it going to be a 2010 event, or is this going to flip in to next year do you think?

Don't really know yet, Heidi.

It's -- I mean clearly when we get within 18 to 24 months of something major like that, we're going to need to start pulling some triggers.

All right.

And then another question, as we think about this rate uptick, can you give us some sense, Jeff, as to kind of what rate should we be thinking about you guys on the 787 in the back half of this year and into 2011?

Just maybe put some dotted lines between the two a month on route to the seven a month, how you're going to get there?

Well, just in general, Heidi, as you know, getting to seven a month or ten or whatever it ultimately happens to be, needs to be done in rational steps.

The first, the front end of a production ramp-up tends to be more, less a specific rate step and more a gradual buildup.

Probably when you get to two a month, then you go to three, then to potentially four or five.

You try to make it -- you try to make it in more definitive steps rather than just a whole series of small ones.

And so if you take a line and draw it from where we are to where we need to be to meet the customer demand, and by the way, they haven't been terribly specific on what their delivery forecast is, you back that off -- back that off to our lead time and you get the kind of steps that we need to take.

But by 2011, I mean, three, four, five -- I mean can you maybe give us some numbers behind -- the concept is great and helpful, but can you put some numbers behind it too?

We have not forecast or we haven't announced that, Heidi, but again we're going to -- as the customer announces what they're going to deliver, we're going to be in synch with our appropriate backup for that.

All right, thanks.

Thanks, guys.

Thank you.

Thanks, Heidi.

Ladies and gentlemen, thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Good day.